Gilt Funds Explained: Returns, Risks and Who They Suit
A gilt fund lends your money to exactly one borrower: the Government of India. A gilt fund is a debt mutual fund that must keep at least 80% of its assets in government securities, so it carries almost no risk of the borrower defaulting, but plenty of risk from moving interest rates.
That trade is the whole story. You give up credit risk and take on price risk, which means the net asset value can fall in a month even though the government has paid every rupee it owes.
What follows: how these funds earn, the two SEBI categories, what a 0.50% yield move does to your NAV, the tax rules after the 2023 change, and who they suit.
Where the returns come from
The first of two sources is accrual: the coupon interest paid by the government securities held. Steady and positive. If the portfolio yields around 7%, roughly that much accrues over a year before costs.
The second is capital gain or loss on the bonds. Prices move opposite to yields. When market yields fall, the older higher-coupon bonds become more valuable and the NAV jumps. When yields rise, the same bonds are worth less and the NAV drops.
In a calm year accrual dominates and the fund looks sleepy. In a year when the Reserve Bank of India shifts stance, the capital gain or loss can be several times the accrual, which is why last year’s return says little about the next.
The two categories you will see
- Gilt Fund: at least 80% in government securities across any maturity. The manager can shorten or lengthen the portfolio on a rate view, so duration moves around.
- Gilt Fund with 10 year constant duration: at least 80% in government securities, with the portfolio held near a Macaulay duration of 10 years at all times. There is no hiding place if rates rise, because the mandate forbids turning defensive.
The constant duration version is the purer rate bet. The flexible one needs the manager to read the cycle correctly. Both sit inside the wider debt bucket in our guide to the types of mutual funds in India.
Worked example: what a 0.50% yield move does
Duration measures the sensitivity. A rough rule works: the percentage change in NAV is approximately modified duration multiplied by the yield change, with the sign flipped.
Take a gilt fund with a modified duration of 7 years and an NAV of Rs 40. You hold 2,500 units, so your money is worth 2,500 multiplied by Rs 40, which is Rs 1,00,000.
Yields now fall by 0.50%, or 50 basis points. Price effect: 7 multiplied by 0.50% equals a 3.5% gain. NAV moves from Rs 40 to about Rs 41.40, and the holding is worth roughly Rs 1,03,500.
Add accrual. Six months at a 7% portfolio yield is roughly another 3.5% before costs, so a six month return near 7% is possible, which annualised looks striking for a debt fund.
Reverse the move and the arithmetic is as blunt. Yields rise 0.50%, the price effect is a 3.5% loss, NAV slips to about Rs 38.60, and six months of accrual barely gets you to flat.
Duration sensitivity at a glance
| Modified duration | Yields fall 0.25% | Yields fall 1.00% | Yields rise 0.25% | Yields rise 1.00% |
|---|---|---|---|---|
| 2 years | +0.5% | +2.0% | -0.5% | -2.0% |
| 5 years | +1.25% | +5.0% | -1.25% | -5.0% |
| 7 years | +1.75% | +7.0% | -1.75% | -7.0% |
| 10 years | +2.5% | +10.0% | -2.5% | -10.0% |
These are price effects only, before coupon accrual and costs, and they are approximations. Close enough to size a position honestly.
Are gilt funds safe?
Safe against default, yes. The borrower is the sovereign, so credit risk is as low as rupee assets get.
Not safe against loss. A gilt fund is marked to market, so a lump sum invested just before a yield spike shows red. No maturity date pulls your value back to par the way a deposit does.
SEBI requires a riskometer on every scheme, refreshed monthly, and long duration gilt funds usually sit higher on it than short duration debt funds. Our explainer on mutual fund risk ratings covers how to read that dial. For parking money for a few weeks, a liquid fund is the right tool, not this.
How are gilt funds taxed in India?
This changed, and the change matters. Debt mutual fund units bought on or after 1 April 2023 are specified mutual funds under Section 50AA. Gains are taxed at your income tax slab rate no matter how long you hold, with no indexation and no separate long term rate.
So a 30% slab investor with a Rs 50,000 gain pays slab rate tax on it, whether the holding lasted eight months or five years.
So gilt funds suit lower slabs better, and the old three year hold for indexed treatment no longer applies. Our piece on how mutual fund returns are taxed sets out the equity and debt rules side by side.
Who do gilt funds suit, and how do you pick one?
- An investor with a view that rates are heading lower, and two to three years to be proved right.
- Someone building a long horizon debt allocation who wants sovereign quality and can sit through NAV swings.
- An investor in a lower tax slab, where slab rate taxation on debt gains is not punishing.
- A portfolio whose emergency money already sits in a liquid fund, so this is never the pot needed next month.
To choose between two, skip the one year return ranking, which mostly shows who took the most duration in the last rally. Compare average maturity and modified duration, since that is your real exposure. Check the expense ratio too: on a product yielding around 7%, a 0.30% cost gap matters, and the direct plan always costs less than the regular plan.
Risk note: none of this is a return forecast. Rate moves are hard to predict, and professional managers get the timing wrong for stretches long enough to hurt.
Frequently Asked Questions
Can a gilt fund give negative returns in a year?
Yes. If yields rise enough, the mark-to-market loss on the bonds exceeds the coupon accrual for the year and the NAV ends lower than it started. The government has still paid everything it owes. The loss comes from bond prices, and it reverses only if yields fall back or accrual catches up.
Is a gilt fund better than a bank fixed deposit?
Different products. A deposit has a contracted rate and returns principal on maturity, so the outcome is known. A gilt fund has no maturity date, no promised rate, and moves with yields. Gilt funds can beat deposits in a falling rate phase and lag in a rising one. If certainty matters more, the deposit wins.
How long should I hold a gilt fund?
Roughly match your horizon to the fund’s duration. With a modified duration near 7 years, plan on at least two to three years so accrual can absorb an adverse rate move. Buying a 10 year constant duration fund for a six month goal is a bet on timing, not an investment plan.
Do gilt funds invest in state government bonds too?
Many do. State development loans are sovereign-backed borrowings and often yield slightly more than central government securities of similar maturity. The factsheet shows the split. It does not change the basic profile much, since credit risk stays very low and interest rate risk remains the dominant factor.
Should I do a SIP in a gilt fund or invest a lump sum?
A SIP spreads your entry across yield levels, which lowers the chance of committing everything just before a rate spike. That helps precisely because rate timing is hard. A lump sum makes sense only if you hold a firm view that yields are near a peak and can tolerate being early.
Which is riskier, a gilt fund or a corporate bond fund?
Risky in different ways. Gilt funds carry near zero credit risk and high interest rate risk. Corporate bond funds add credit risk, since an issuer can be downgraded, while often running shorter duration. A long duration gilt fund can swing more month to month than a corporate bond fund, even though its borrower is safer.
Key Takeaways
- A gilt fund holds at least 80% in government securities, so default risk is minimal and interest rate risk is the real exposure.
- Estimate the move as duration multiplied by yield change: duration 7 with a 0.50% yield rise is roughly a 3.5% NAV fall.
- The 10 year constant duration category cannot turn defensive when rates rise, because its mandate fixes the duration.
- Units bought on or after 1 April 2023 are taxed at your slab rate under Section 50AA, with no indexation, however long you hold.
- Use liquid or overnight funds for short term parking, and gilt funds only for a rate view or a long horizon allocation.
- Compare on duration and expense ratio across full rate cycles, not on last year’s return.
